When viewed through the lens of real rates, it’s hardly surprising that any and all manifestations of “froth” were beset three weeks into the new calendar.
10-year real yields in the US came into Friday at -50bps, and it’s fairly obvious we’ve crossed the pain threshold. Generally speaking, a two-standard deviation move (higher) in nominals over a one-month period is too much for equities to stomach. A near 50bps increase in real yields over four weeks is tantamount to food poisoning.
The figures (below) will be familiar to regular readers. They’re updated through January 20. 2022’s burgeoning real rates shock (or “tightening tantrum,” if you prefer) is the story right now.
Frankly, it’s a small miracle stocks haven’t sold off more at the index level considering the weight of mega-cap growth shares in the benchmarks and the extent to which big tech arguably maxed out its melt-up potential in 2020, when pandemic dynamics added a kind of existential macro kicker to an already robust fundamental bull case.
I’ve argued that markets have actually been a semblance of efficient over the past 12 months. Virtually everything synonymous with so-called “hyper-growth” as well as myriad pockets of speculative excess have suffered acute drawdowns at one point or another.
The de-rating in the Cathie Wood complex, related declines in profitless growth shares and the fact that the crypto generals (e.g., Bitcoin, Ether, Avalanche and Solana) were already nursing steep losses prior to the Thursday-Friday rout, suggests the market has at least tried to price in the dynamics that are finally starting to show up above the fold in the financial pages.
The figure (above) makes the point. ARKK was at $122 at the end of October. It’s at $75 now. Solana (an “Ether killer”) is down 55% over the same period. And counting.
Investors got a dress rehearsal of this show during the first quarter of 2021 (ironically accompanied by the meme stock mania, one of the more poignant examples of speculation run amok). Speculative corners of the market have been on edge since. Now, the show is live — this is the “real” deal, pardon the bad pun.
Below is another familiar chart, updated for this week. Outside of the anomalous swings associated with the onset of the pandemic, the recent surge in real rates is among the largest in recent memory.
“Equities struggle to digest sharp changes in interest rates, especially when driven by the real component, as has been the case since the start of the year,” Goldman’s Christian Mueller-Glissmann wrote Thursday.
Deeply negative real rates can be construed as a comment on purportedly dour economic prospects. But in the pandemic era, they’ve been a testament to aggressively accommodative monetary policy and the mechanical impact of rising breakevens.
Those drivers are going into reverse now. The accompanying surge in real rates is thus highly destabilizing. Traders see it for exactly what it is: A reaction to imminent policy tightening, not the product of markets upgrading their growth outlook. If anything, flagging breakevens suggest the growth outlook is deteriorating, as expectations for aggressive Fed hikes to counter inflation raise the specter of a policy mistake.
The accompanying surge in real rates is thus highly destabilizing. Traders see it for exactly what it is: A reaction to imminent policy tightening, not the product of markets upgrading their growth outlook. If anything, flagging breakevens suggest the growth outlook is deteriorating, as expectations for aggressive Fed hikes to counter inflation raise the specter of a policy mistake.
That’s the part that kills me. Maybe I should have spent more time with FI and cross asset teams but the Fed hasn’t done a thing YET. What are the chances that, after raising in March and maybe June, they see inflation rolling over and growth flagging and, despite that, they then keep pushing with a third or fourth hike?
If I am right that inflation has peaked and will start coming down in H1 2022, I don’t expect the Fed to do more than 2 hikes…
This is my view on inflation, I think once the base effects have washed through the numbers will get pushed down. In addition, technology and demographics continue to act as deflationary forces. Let’s hope the Fed doesn’t mess this one up!
Demographics and immigration policy are currently inflationary in the US:
– population growth is stagnant and age skews older over time
– immigration has been greatly curtailed in the past years and fewer people want to come (notice how Canada’s Central Bank is counting on increased immigration over the past year to not need to hike rates as much to tame inflation: https://www.bnnbloomberg.ca/rush-of-immigrants-to-slow-bank-of-canada-rate-hikes-cibc-says-1.1710578)
Guessing when the Fed will restart accommodation is akin to guessing when the next economic crisis will befall us. Republican presidents have a good track record of leaving the economy in shambles, prompting the Fed to help. Perhaps 2026 is as good a guess as any for when the Fed will dust off the printing press.
I don’t necessarily suggest (and I don’t think Grossmith was either) that the Fed will have to flood the market with liquidity as soon as June 2022.
But they can… do nothing. If inflation and growth are flagging by then, that’ll seem the right response to me.
Lets see what the Fed says after they meet next week. So far, just “talk”. Seems like the Fed does not have to actually “do” anything. Just talk, walk back the talk, etc.
When the Fed talks we have to listen ..When the markets talk they have to listen. This is the way it will go…
Sure, I agree with you both.
But as you said, they can walk back their talk etc. It remains “data dependent”. I don’t have a problem with them taking inflation seriously. It’s been higher and lasted longer than most people, me included, expected.
I don’t see a wage price spiral (yet?) and dispersion across categories is limited (still?). But treating both issues seriously is why we pay those central bankers so fair enough. Some talk, removing liquidity injections seem fine. Projecting 4 hikes for the next 12 months? Errr… seems premature.
While I think most supply chain issues will sort themselves out in relatively short order, there are more durable forces pushing prices in the other direction. Our short sighted energy policies are unlikely to change during this administration. Fertilizer costs increased more last year than they have since 2008, so forget food prices coming down anytime soon. Housing/rent? Wages? What besides a general collapse in all financial assets will drive these things lower? The Fed is walking a fraying tightrope.
Well, to be fair, I’m not sure “short sighted” is the best way to describe a push to transition away from fossil fuels. Maybe “haphazard” is a better adjective. I totally understand and agree with the contention that trying to switch to renewables overnight is destined to end in price volatility (and worse), but if we don’t make the transition, we’re going to go extinct within a century or two. That’s just the reality of the situation, I’m afraid. It’s another one of those issues where it would be immensely helpful if everyone would go ahead and admit the obvious so that the debate can be constructive. As long as one side still insists there’s no such thing as climate change, it’s impossible to meet in the middle because like so many other issues, one of America’s two political parties lives in an alternate reality where global warming isn’t real. It was 82 here yesterday. It’s 36 today.
From my perspective the Fed has already made two policy mistakes …
1) Overzealous QE amount.
2) Misreading Inflation dynamics
Even if both policy mistakes were anticipated and factored in correctly and trading choices were pretty well placed what remains is a tough environment for success. Reason being for the last 20 years the US Govt. has been so divided and leaderless that none of the major problem areas have been able to find reasonable solutions that the two block headed extremes can agree on. Every 4-8 years there is a 180 degree change of direction to undo anything resembling progress .
H-Man, why not say “puke”.
NDX and SP50 are just effortlessly sliding through support levels. No matter how oversold on price and sentiment, they can’t hold a level. And the big names – AAPL, MSFT, etc – don’t look good. Other names that fundamentally should be largely unaffected or even helped by inflation, rising rates, supply chain disruption are starting to roll over anyway. I’ve been cutting exposure since, well, last year and doesn’t feel like I’ve done enough.
@JYL: we are in the same boat, it felt like boarding a ship of fools at first, but now I’m wondering too, did I squirrel away enough of those LTCGs when the selling was leisurely? Fruitless to worry about it. All that matters was we captured gains methodically on the way up while trying to squeeze more out of a shrinking risk exposure. Selling what’s left now is not much different numerically on average (it is in reverse now) than when you trimmed more and more aggressively as 2021 got stretched. Except for the different tax year. Nobody can perfectly call the top or the exact moment of ‘regime’ change. Some old timer, I think it was a Rothschild, said back before “administered-Markets” that, “nobody went broke taking 20%”.
Cheer up. Even if you are still shedding IR sensitive growth bits today, looking at the charts in a few months you will feel like a genius if the ship sinks like a rock faster than speeding central bankers can open a TARP beneath it. It is getting hard to deny the trend is bending, not quite broken, but bending hard. 200dma’s are getting crossed from above all around. This is the path to sideways at the very least. In which case the ‘rules’ are changing. You know those times in the past when you stared at the long-term charts and imagined what it must of been like back there near the top, or within a few squiggles of the precipice, and thought if they’d just gotten out then instead of trying to hang on for a few more shekels… deja vu all over again? Those “lower highs and lower lows” always look so obvious in those charts. Will they look as obvious in today’s charts? I’d wager there will be fewer cautionary ’rounded’ speed-bumps visible to the naked-eye in an era of HFT and learned machines driving correlations to 1 faster and faster with each new chip upgrade.
@John Banjo is correct. Some bankers seem a bit to complacent there will be a perfectly executed Fed dovish-pivot the instant the Sun starts melting the wax holding their pinions leveraged into place. If their wrong they’ll be dead or less and an icky mess.